First Look

December 20, 2011

Making Decisions Unconsciously

A recent theory posits that the unconscious mind is capable of making complex decisions, sometimes even better than the conscious mind. New evidence indicates that conscious and unconscious thoughts tend to tackle problems from opposite directions, say researchers Loran F. Nordgren, Maarten W. Bos, and Ap Dijksterhuis. In "Unconscious Thought Works Bottom-up and Conscious Thought Works Top-down When Forming an Impression," an article in the December issue of Social Cognition, they find that conscious thinkers tend to rely on stereotypes when forming impressions, while unconscious thinkers are more likely to consider stereotype-incongruous information.

The Impact Of Modularity

Many firms now encourage innovation not only within the organization, but among their global suppliers and even their users, who are invited to contribute to the development of new products and systems. This "distributed innovation" works in part because the firms design their wares as a series of modular components—such that changes within one module won't affect the rest of the system. While this makes logistical sense, it can lead to business problems when multiple modules are vulnerable to intellectual property threats, argue Carliss Y. Baldwin and Joachim Henkel in a new working paper. Read "The Impact of Modularity on Intellectual Property and Value Appropriation.

Entering The Credit Ratings Industry

When the mortgage credit bubble imploded in 2008, credit ratings agencies faced much of the blame for the crisis. In a new case, "Kroll Bond Rating Agency," Bo Becker discusses how a startup took advantage of the obvious room for improvement in the industry, entering the market at a volatile time to compete with big names like Moody's and Standard & Poor's.

— Carmen Nobel


Unconscious Thought Works Bottom-up and Conscious Thought Works Top-down When Forming an Impression


We tested and found supportive evidence for one of the principles of Unconscious Thought Theory (UTT); namely, that unconscious thought is a bottom-up process, whereas conscious thought is a top-down process. In two experiments on impression formation, participants read behavioral information about a fictitious person after a stereotype had been activated. We found that unconscious thinkers formed an impression unbiased by the stereotype, suggesting a bottom-up strategy, whereas conscious thinkers relied on the stereotype, suggesting a top-down strategy. That is, when thinking consciously, participants relied more on stereotype-congruent information and suppressed stereotype-incongruent information. Implications for impression formation are discussed.

Inducement Prizes and Innovation


We examine the effect of prizes on innovation using data on awards for technological development offered by the Royal Agricultural Society of England at annual competitions between 1839 and 1939. We find that the effects of prizes on competitive entry are large, and we also detect an impact of the prizes on the quality of contemporaneous patents, especially when prize categories were set by a strict rotation scheme, thereby mitigating the potentially confounding effect that they targeted only "hot" technology sectors. Prizes encouraged competition and medals were more important than monetary awards. The boost to innovation we observe cannot be explained by the redirection of existing inventive activity.

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Finding the Right Mix: How the Composition of Self-managing Multicultural Teams' Cultural Value Orientation Influences Performance Over Time


This research investigates a new type of team that is becoming prevalent in global work settings, namely, self-managing multicultural teams. We argue that challenges that arise from cultural diversity in teams are exacerbated when teams are leaderless, undermining performance. A longitudinal study of multicultural MBA study teams found that in the early stage of team formation, teams with a low average level of, but moderate degree of variance in, uncertainty avoidance performed best. Four months post formation, however, teams with a high average level of relationship orientation performed better than teams with a low average level of relationship orientation. Furthermore, a moderate degree of variance in relationship orientation among team members produced better team performance than a low or high degree of variance. These findings suggest that different cultural value orientations exert different patterns of effects on the performance of self-managing multicultural teams, depending on the stage of team formation. Implications for the composition of self-managing multicultural teams and its influence on team processes and performance are discussed.

What Drives Sell-Side Analyst Compensation at High-Status Investment Banks?


We use proprietary data from a major investment bank to investigate factors associated with analysts' annual compensation. We find compensation to be positively related to "All-Star" recognition, investment-banking contributions, the size of analysts' portfolios, and whether an analyst is identified as a top stock picker by The Wall Street Journal. We find no evidence that compensation is related to earnings forecast accuracy. But consistent with prior studies, we find analyst turnover to be related to forecast accuracy, suggesting that analyst forecasting incentives are primarily termination based. Additional analyses indicate that "All-Star" recognition proxies for buy-side client votes on analyst research quality used to allocate commissions across banks and analysts. Taken as a whole, our evidence is consistent with analyst compensation being designed to reward actions that increase brokerage and investment-banking revenues. To assess the generality of our findings, we test the same relations using compensation data from a second high-status bank and obtain similar results.

The Best of Both Worlds: Integrating Conscious and Unconscious Thought Best Solves Complex Decisions


Two studies address the debate over whether conscious or unconscious mental processes best handle complex decisions. According to Unconscious Thought Theory (Dijksterhuis & Nordgren, 2006), both modes of thinking have particular advantages: conscious thought can follow strict rules, whereas unconscious thought is better suited for integrating numerous decision attributes. Because most complex decisions require both adherence to precise rules and the aggregation of information, we hypothesized that complex decisions can best be made by engaging in periods of both conscious and unconscious thought. In both studies we found that the sequential integration of conscious and unconscious thought solved complex choices better than conscious or unconscious thought alone. In Study 2 we examined whether the sequential order of the integration condition matters. In line with our prediction, we found that integration worked best when unconscious thought followed conscious thought.

Teaching Leadership: Advancing the Field

An abstract is unavailable at this time.


A Meta-analysis on Unconscious Thought Effects


A meta-analysis was performed on the unconscious thought effect (UTE). All available published and unpublished data on unconscious thought were included. Our aims were to provide a statistically robust estimate of the effect size of the UTE, to identify significant moderators, and to discuss possible underlying processes of the UTE. To assess the UTE, performance of participants thinking unconsciously was compared to participants thinking consciously, and to immediate decision makers. Across a total of 92 studies, the overall aggregated effect size was g = .224, with a 95% confidence interval from .145 to .303. This result provides strong support for the existence of the UTE. However, as estimated from a random-effects model, about 66% of the variance in effect sizes was attributable to systematic differences between studies. This result indicates that although the UTE is a real effect, it does not always occur. Several moderators were identified that help to explain the mixed results across various studies. The findings are discussed with regard to the boundary conditions and potential underlying processes of the UTE.


Working Papers

The Impact of Modularity on Intellectual Property and Value Appropriation


Distributed innovation in open systems is an important trend in the modern global economy. In general, distributed innovation is made possible by the modularity of the underlying product or process. But despite the documented technical benefits of modularity, history shows that it is not always straightforward for firms to capture value in a modular system. This paper brings together the theory of modularity from the engineering and management literatures with the modern economic theory of property rights and relational contracts to address the question of value appropriation. It defines three generic threats to intellectual property (IP) and models the interactive impact of modularity and state-sanctioned IP rights on these threats. It identifies strategies for capturing value in so-called "open systems" in which IP is distributed among several parties. It shows why open systems should be designed as modular systems. Finally, it analyzes in detail the strategy of capturing value by maintaining exclusive control of an essential module in an open system.

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Fiduciary Duties and Equity-Debtholder Conflicts


We use an important legal event as a natural experiment to examine the effect of management fiduciary duties on equity-debt conflicts. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors' fiduciary duties in firms incorporated in that state. This change limited managers' incentives to take actions favoring equity over debt for firms in the vicinity of financial distress. We show that this ruling increased the likelihood of equity issues, increased investment, and reduced firm risk, consistent with a decrease in debt-equity conflicts of interest. The changes are isolated to firms relatively closer to default. The ruling was also followed by an increase in average leverage and a reduction in covenant use. Finally, we estimate the welfare implications of this change and find that firm values increased when the rules were introduced. We conclude that managerial fiduciary duties affect equity-bondholder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare.

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The Evolving Basis for Legitimacy of the World Trade Organization: Dispute Settlement and the Rebalancing of Global Interests


The World Trade Organization (WTO) features prominently in studies of international institutions, although it is often over-simplified either as a tool of rich world domination over the global South or as the only stop-gap preventing a breakdown in the international system. This article analyzes how the WTO has sought legitimacy for itself and for the underlying institution of free trade in the midst of questions regarding its organizational mandate and the management of international trade negotiations. Initially, legitimacy appeared to derive from an expanding membership and the lowering of tariffs in progressively more categories of goods and services. More recently, legitimacy comes from institutional deepening by means of dispute resolution procedures and rulings by the dispute settlement body. This shift, it is argued, raises foundational questions of expertise, the relationship of models to real-world outcomes, and methods for bounding disputes over scientific and economic facts. Based on a case study of Brazil's interaction with the WTO-especially in a decade-long claim against U.S. cotton subsidies—and a trend analysis of over 400 total WTO disputes, I argue that the WTO dispute process is helping to legitimize the institution of free trade through its public display of rational authority and neutral expertise. At the same time, dispute panels have begun to pass judgment on issues of scientific and econometric uncertainty. As a result, the basis for dispute judgment and the broader legitimacy of the WTO is shifting from questions of representation that have long drawn the attention of critics and WTO leaders to epistemological issues, especially concerning the basis of expertise and the design of econometric models. This article provides insights on the resolution of disputes in global trade while contributing to our understanding of the evolving role of scientific and econometric modeling at international organizations.

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What Makes the Bonding Stick? A Natural Experiment Involving the Supreme Court and Cross-Listed Firms


Using a natural experiment to overcome the empirical challenges facing the debate over the bonding hypothesis, we analyze markets' reaction to a sudden radical change in the law governing U.S.-listed foreign firms. In March 2010, the U.S. Supreme Court signaled its intention to geographically limit the reach of the U.S. antifraud regime. The Court thus excluded the overwhelming majority of investors in U.S.-listed foreign firms from the protection of the U.S. civil liability regime and cast at least partial limitations on the SEC's regulatory authority. This event nonetheless was met with positive abnormal returns of U.S.-listed foreign firms in both home and U.S. markets. These abnormal returns are actually higher the greater the percentage of a firm's capital listed on non-U.S. exchanges but are unrelated to the corporate governance and legal environment in foreign issuers' home country. These results challenge the legal bonding hypothesis while suggesting that the U.S. regime of civil liability as currently designed may not have been seen as a source of economic value for outside investors.

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Observation Bias: The Impact of Demand Censoring on Newsvendor Level and Adjustment Behavior


In an experimental newsvendor setting we investigate three phenomena: level behavior-the decision-maker's average ordering tendency; adjustment behavior- the tendency to adjust period-to-period order quantities; and observation bias-the tendency to let the degree of demand feedback influence order quantities. We find that the portion of mismatch cost due to adjustment behavior exceeds the portion of mismatch cost due to level behavior in three out of four conditions. Observation bias is studied through censored demand feedback, a situation that arguably represents the majority of newsvendor settings. When demands are uncensored, subjects tend to order below the normative quantity when facing high margin and above the normative quantity when facing low margin, but in neither case beyond mean demand (a.k.a. the pull-to-center effect). Censoring in general leads to lower quantities, magnifying the below-normative level behavior when facing high margin but partially counterbalancing the above-normative level behavior when facing low margin, violating the pull-to-center effect in both cases.

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Cases & Course Materials

Kroll Bond Rating Agency

Bo Becker
Harvard Business School Case 212-034

The established credit raters were criticized for inflating the mortgage credit bubble that imploded in 2008. A new rating agency, KBRA, is considering how to capitalize on the opportunity this presents and how to enter the industry. A small group of managers have to decide on a business model, how to meet hiring and funding needs, and what types of ratings to start with: municipal, corporate, or structured. Where are the needs for new ratings stronger? How can investors be convinced to use the new ratings? How can KBRA compete with Fitch, Moody's, and S&P?

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A New Financial Policy at Swedish Match

Bo Becker and Michael Norris
Harvard Business School Case 212-017

Swedish Match is a profitable smokeless tobacco company with low debt compared to other firms in its industry. The firm's CFO now wants to revise its conservative financial policy.

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Ganesh Natarajan: Leading Innovation and Organizational Change at Zensar (A)

Michael L. Tushman and David Kiron
Harvard Business School Case 412-036

In 2005, Ganesh Natarajan, CEO of Zensar, a Pune, India-based software company, and his senior management team are considering consolidating staff and resources at the firms. Natarajan proposes an additional, possible controversial business unit to the proposed new structure. The additional unit would explore new markets for the firm's promising innovation-Solution BluePrint (SBP). While he knew that some on his team would resist his proposal, he was eager to get the new technology into the field and felt he had the right manager to lead the proposed group. Natarajan felt sure a group dedicated to SBP led by one of the firm's most respected technologists would help spur adoption.

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Duke Energy and the Nuclear Renaissance

Richard H.K. Vietor and Forest Reinhardt
Harvard Business School Case 712-002

Duke Energy, an American investor-owned electric utility, confronts multibillion-dollar decisions about its future fuel mix. In particular, its leaders are considering building new nuclear capacity. Whether this is sensible depends, among other things, on demand growth, capital costs, fossil fuel prices, possible regulatory or other delays in constructing the reactors, and possible future restrictions on carbon dioxide. CEO Jim Rogers believes that nuclear power makes sense from a social standpoint but must also consider the perspectives of his ratepayers and his shareholders.

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